amac. 11. decision making techniques (copy)

Formula for Contribution per unit

Selling price per unit – Variable cost per unit

Formula for Total Contribution

Total sales revenue – Total variable costs

When is contribution used for decisions?

When fixed costs will not change and should not affect decision-making (short-term decisions).

Definition of Relevant costs

Costs appropriate to a specific management decision.

Characteristics of relevant costs

• Future

• Incremental

• Cash flow (actual cash movements)

Which costs are NOT relevant?

• Sunk costs

• Committed costs

• Non-cash accounting adjustments (depreciation, accruals)

What is Opportunity cost?

The benefit given up when choosing one option over the next best alternative.

Relevant costs in make-or-buy decisions

• All variable costs

• Avoidable fixed costs (directly attributable)

• Opportunity costs

non financial considerations in make or buy decisions

advantages

• Cost flexibility: Outsourcing partner may offer cost savings.

• Access to expertise: Organisation gains specialist skills that may not be available in-house.

• Capital release: Money tied up in equipment or production can be used elsewhere.

• Better resource use: Internal staff/resources can focus on higher value-adding activities.

non financial considerations in make or buy decisions

disadvantages

• Loss of control: Organisation no longer controls operations directly.

• Quality risk: Product quality may decline if the outsource partner’s processes are not as strong.

• Reliability issues: Outsourced supplier may prioritise other customers.

• Confidentiality risks: Sensitive information shared with supplier could be misused.

• Loss of internal skills: Harder to bring production back in-house in the future.

• Employee impact: Redundancies may occur, reducing morale and motivation.

What are shutdown decisions?

Whether to close a product line/department temporarily or permanently when it is loss-making or uneconomic.

Relevant costs in shutdown decisions

Same principles as make-or-buy: only future and avoidable costs are relevant.

What is the key factor?

The resource that limits output (e.g., labour hours, machine hours, materials).

Contribution per unit of scarce resource

Contribution per unit ÷ Scarce resource per unit

When is linear programming used?

When there is more than one limiting factor.

What are the two methods of solving linear programming?

• Graphical method

• Simultaneous equations

Give two assumptions of linear programming.

• Linear relationships

• Divisible outputs

• Objective is maximisation/minimisation

• Fixed resource constraints

What is the main tool used in short-term decision making?

Contribution, not profit.

Why is staff morale a key non-financial consideration when shutting down a product or department?

Staff may need redeployment or may be made redundant, which negatively affects morale and motivation.

How can shutdown decisions affect customers?

Customers may switch to competitors, leading to loss of market share.

What is the risk to suppliers when a shutdown occurs?

Some suppliers rely on the organisation; stopping production could severely impact them.

Should shutdown decisions be based only on financial analysis?

No — qualitative impacts (staff, customers, suppliers) must also be considered.

What is a scarce resource?

A factor that limits the number of units that can be produced or sold (e.g., materials, labour hours, machine hours, plant capacity, factory space, access to finance).

What is the goal in key factor analysis?

To maximise profit by maximising contribution earned per unit of scarce resource.

Formula for contribution per unit of scarce resource

Contribution per unit ÷ Limiting factor per unit.

What is an optimal production plan?

The combination of products that uses the scarce resource in the most profitable way.

Steps in calculating the optimal production plan?

(a) Identify limiting factor
(b) Calculate contribution per unit
(c) Calculate contribution per unit of limiting factor
(d) Rank products
(e) Allocate resource to maximise contribution

What costing method is used for short-term decisions?

Marginal costing (focus on contribution; fixed costs are constant).

What costs are relevant in make-or-buy and discontinuation decisions?

Variable costs saved or incurred + any avoidable fixed costs.

Why is capital investment important in long-term decisions?

Long-term decisions often require new machinery or major investment expected to benefit the business for years.